Sometimes covered calls are also known as buy writes. They are a common technique used to trade in shares, foreign exchange, and other securities. In lay terms a cover call is a strategy where an investor holds a long position then waits for an opportunity for him to write call option. If this opportunity avails itself he has a chance of increasing his income.
If you use this tool well, covered call trading strategy has the ability to generate some good profits in the long run of any security. This tool is generally considered safe if not conservative though, it has a number of flaws which we are going to have a look at. We are also going to see all the ups and downs that surround this tool.
Before we continue, a few definitions are going to help us in discussing this tool: Long call option - Here an investor buys a right or privilege to buy a given security at a predetermined date within a specific price. To get this right, he has to part with some money today, called premium.
Sell call option - This is an instance where you are the issuer of the long the call option. In this case the person whom you are offering the right pays you. Short the put option. Here you give an investor or trader a right to sell at a future date in which he does not have to sell to you. Basically these are the underlying points in any buy write strategy.
The next thing is how to set up this strategy. You will first need to identify a stock or security that has good long term prospects. After this, you will have to make two simple actions. First, you need to buy 100 or more shares. This will be dependent on how much you are willing to put into the investment.
The next thing would be to sell 1 call contract per 100 shares you just purchased. This will generate some income. While this sounds simple the selling is the tricky part you will have to determine when to sell. This is because if the call expires in the money you will have to sell the shares you just bought.
Below is an example of how this works. Assume an investor has 500 shares valued at $10000. He decides to sell 5 call options at a cost of $1500. One option call covers 100 shares.
Basically this move is a safe move. You will only lose money if the stocks were to drop by more than $1500. On the downside you are not allowed to buy these calls at a lower price than you bought them once the period expires. This is one of the disadvantages of covered calls. Basically this is how to use this strategy, though there are some few dynamics which the scope of this article does not allow as to venture into.
If you use this tool well, covered call trading strategy has the ability to generate some good profits in the long run of any security. This tool is generally considered safe if not conservative though, it has a number of flaws which we are going to have a look at. We are also going to see all the ups and downs that surround this tool.
Before we continue, a few definitions are going to help us in discussing this tool: Long call option - Here an investor buys a right or privilege to buy a given security at a predetermined date within a specific price. To get this right, he has to part with some money today, called premium.
Sell call option - This is an instance where you are the issuer of the long the call option. In this case the person whom you are offering the right pays you. Short the put option. Here you give an investor or trader a right to sell at a future date in which he does not have to sell to you. Basically these are the underlying points in any buy write strategy.
The next thing is how to set up this strategy. You will first need to identify a stock or security that has good long term prospects. After this, you will have to make two simple actions. First, you need to buy 100 or more shares. This will be dependent on how much you are willing to put into the investment.
The next thing would be to sell 1 call contract per 100 shares you just purchased. This will generate some income. While this sounds simple the selling is the tricky part you will have to determine when to sell. This is because if the call expires in the money you will have to sell the shares you just bought.
Below is an example of how this works. Assume an investor has 500 shares valued at $10000. He decides to sell 5 call options at a cost of $1500. One option call covers 100 shares.
Basically this move is a safe move. You will only lose money if the stocks were to drop by more than $1500. On the downside you are not allowed to buy these calls at a lower price than you bought them once the period expires. This is one of the disadvantages of covered calls. Basically this is how to use this strategy, though there are some few dynamics which the scope of this article does not allow as to venture into.
About the Author:
This piece on covered calls is brought to you by Born To Sell. Born To Sell's company website has a free tutorial and blog on covered call investing.
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